Three big (new) things you need to know: First, equity investors have been asking us whether inflation has been good for stocks and earnings. We think that it has, and view moderating inflation as more of a headwind in the outlook for stocks than many investors may realize. Second, a number have asked our opinion on the low quality trade. We’ve reminded investors that low quality tends to outperform after the stock market has found its mid-recession bottom. We’d expect the same this time around for a short period of time. Third, a number have asked if we could dig deeper on our sector recession playbook analysis, and we’ve replicated it for the 24 industry groups. Areas that tend to outperform during recessions as well as the broader market drawdown and rebound phases include Commercial & Professional Services, Consumer Services, Materials, Retailing, and Transportation.
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Takeaway #1: We Think Inflation Has Been More Good Than Bad For Stocks
The question of whether inflation has been good or bad for stocks, particularly earnings, is the most interesting question we’ve gotten recently. Our take: we do think inflation has been good for equities and see the potential for inflation to moderate from here as a headwind that should be factored into equity outlooks.
In terms of earnings, we see two clear ways that inflation has been good for stocks. First, S&P 500 revenues have been highly correlated with trends in CPI over time, with a correlation that’s been a tiny bit higher than what we seen for GDP. Pause / Flip to slide 3 Second, we’ve generally found that inflation based indicators like copper have been positively correlated with trends in margins. Have higher commodities and input costs been a pressure on margins? Absolutely. But what our back testing and modeling tells us matters more is the health of the economic cycle and strong commodities and inflation have generally reflected that strength. Pause / Flip to slide 4
a problem for US equities in:
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Moving on to Takeaway #2: We’d Expect Low Quality To Work Well After A Bottom In Stocks Is Established For a Short Period of Time
Most of the investors we’ve been speaking with have cleaned up their portfolios, trimmed positions, and have become more concentrated in higher quality names, leaving many feeling like they are in a good position to weather whatever storm is coming. In this context, the big risk to their portfolios is not if the stock market keeps falling, but if a bottom is established and a rebound takes hold. In this context, they’ve been asking us about the fate of low quality stocks.
noticeably within the Russell:
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Wrapping up with takeaway #3: The Historical Recession Playbook For The 24 Industry Groups
industry groups using the S&P:
Two things caught our eye. First, areas that tend to outperform during recessions as well as the broader market drawdown and rebound phases include Commercial & Professional Services, Consumer Services, Materials, Retailing, and Transportation.
Second, Autos & Components, Banks, Cap Goods, Diversified Financials, Insurance, Media & Entertainment, Real Estate, Semis & Semi Equipment, Software & Services, and Tech Hardware & Equipment tend to underperform in the broader stock market drawdown phases but outperform in the rebound phases.
History is unlikely to repeat exactly this time around, but is a useful place to start when thinking about next moves.
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That’s all for now. Thanks for listening. And be sure to check out our sister podcast, RBC’s Industries in Motion, for additional thoughts on specific sectors from RBC’s team of equity analysts.
